No-Fault’s ‘Innocent Third-Party Rule’ No Longer Exists, Says Michigan Supreme Court

The Michigan Supreme Court recently issued its highly anticipated decision in Bazzi v Sentinel Ins Co, in which a majority of the justices declared that no-fault’s “innocent third-party rule” no longer exists.

The innocent third-party rule has been part of Michigan no-fault jurisprudence for decades. Under the rule, persons injured in auto accidents and the medical providers who treat them have been entitled to personal injury protection (PIP) benefits, even if the insured engaged in fraud when purchasing a no-fault insurance policy.

The Michigan Court of Appeals in Bazzi struck down the innocent third-party rule in 2016, concluding it did not survive the Michigan Supreme Court’s decision in Titan Ins Co v Hyten, 491 Mich 547 (2012).

In a 5-2 decision, the Michigan Supreme Court agreed the innocent third-party rule was abolished by Titan.

However, the Supreme Court also said the Court of Appeals in Bazzi wrongly held that the insurer was automatically entitled to rescission of the no-fault policy. Rather, a majority of the justices said that trial courts must look at each case and balance the equitable remedies. As a result, Bazzi was remanded to the trial court for a determination of whether rescission of the policy was an appropriate remedy.

Auto Accident Injuries

Ali Bazzi was injured while driving a vehicle that was owned by his mother, Hala Bazzi. When he filed a claim for PIP benefits, the no-fault insurer, Sentinel Insurance Company, refused to pay. Sentinel asserted that Hala Bazzi had fraudulently obtained the policy and rescinded it.

Sentinel filed a motion to dismiss Bazzi’s no-fault claim, but the trial court denied the motion. The trial court ruled that Bazzi had a valid claim for PIP benefits pursuant to the innocent third-party rule.

Sentinel appealed. The Court of Appeals ruled in Sentinel’s favor and abrogated the innocent third-party rule. “[I]f an insurer is able to establish that a no-fault policy was obtained through fraud, it is entitled to declare the policy void ab initio and rescind it, including denying the payment of PIP benefits to innocent-third-parties,” the Court of Appeals wrote in a 2-1 decision.

No More Innocent Third-Party Rule

In an opinion written by Justice Kurtis T. Wilder, a majority of the Michigan Supreme Court officially announced the innocent third-party rule did not survive Titan.

The majority pointed out that MCL 500.3112 specifically says no-fault benefits are mandated by statute and a no-fault policy must be read together with the No-Fault Act. “[T]he question is whether the statute prohibits an insurer from availing itself of the defense of fraud,” the majority observed.

According to the Supreme Court, the Legislature’s intent to limit the remedies available to an insurer for fraud should be clearly reflected in the language of the statute. However, in this case, the plain language of the No-Fault Act “does not preclude or otherwise limit an insurer’s ability to rescind a policy on the basis of fraud,” the majority said. “Therefore, Sentinel may raise that defense and seek rescission of the no-fault insurance policy.”

The Supreme Court further found that public policy did not compel the adoption of the innocent third-party rule. “We are not persuaded by the argument … that Titan only addressed the easily-ascertainable-fraud rule and left undisturbed the innocent-third-party rule,” the majority said.

While no-fault PIP benefits are mandated by statute, the No-Fault Act does not prohibit an insurer from invoking the defense of fraud and does not limit the remedy of rescission, the Supreme Court explained. “[A]lthough an innocent third party might have a reasonable right to expect that other drivers carry the minimum insurance required under the no-fault act, that expectation does not, by operation of law, grant an innocent third party an absolute right to hold an insurer liable for the fraud of the insured.”

In other words, the Supreme Court explained, “an insurer has a reasonable right to expect honesty in the application for insurance, and there is nothing in the no-fault act that indicates that the reasonable expectations of an innocent third party surmount the reasonable expectations of the insurer.”

Policy Rescission Is Not A Right

According to the Supreme Court, rescission is not an absolute right but is an equitable remedy. Therefore, Sentinel was not categorically entitled to rescission of the no-fault policy, the majority said, noting that rescission is not permitted when it would be unjust or inequitable.

In this case, rescission did not function by automatic operation of the law, the Supreme Court explained. “Just as the intervening interest of an innocent third party does not altogether bar rescission as an equitable remedy, neither does fraud in the application for insurance imbue an insurer with an absolute right to rescission of the policy with respect to third parties,” the majority wrote.

Instead, equitable remedies must adapt to the circumstances of each case and an absolute approach would “unduly hamper and constrain the proper functioning of such remedies,” the Supreme Court stated. “Therefore, we remand this matter to the trial court to exercise its discretion.”

Dissenting Opinion

Justice Bridget M. McCormack issued a separate dissenting opinion, joined by Justice David F. Viviano.

According to Justice McCormack, the Bazzi case was nearly a “perfect mirror-image of Titan” because it involved statutorily mandated PIP benefits, whereas Titan involved an optional contractual residual-liability insurance. “[Y]et the majority applies Titan’s optional-coverage standard,” she stated.

PIP benefits arise from the No-Fault Act and a no-fault policy must be read together with the act, as if the statute was part of the insurance contract, Justice McCormack explained. “I would hold that MCL 500.3101 limits rescission of PIP benefits, just as MCL 500.3009(1) limits rescission of residual-liability coverage,” she said.

Justice McCormack also criticized the majority’s decision to require “equitable balancing” in every case, saying it “built a bridge to nowhere.”

The majority’s ruling will require “costly litigation to determine in every case who will be the payor and who will be the reimbursor,” the justice wrote. This is “an exercise in futility and is contrary to the Act’s purpose - to ensure prompt coverage and to reduce litigation,” she said. “[T]oday’s decision will delay coverage and increase litigation - a coup for lawyers at their clients’ expense.”

In addition, Justice McCormack called the majority’s decision “a victory only for lawyers.” She pointed out that innocent third parties must be covered somehow because the No-Fault Act requires it, and that equitable balancing cannot impose a remedy that is contrary to law.

“Sentinel’s ‘win’ in today’s innocent-third-party rescission litigation will be another insurer’s loss when the [Michigan Assigned Claims Plan] assigns it to pick up the tab,” the justice said. “Lawyers, on the other hand, have lots of new litigation to pursue.”